Stranded Cost Recovery and Cooperative Electric Utilities

Lyon, Carl F., Jr., Huffman, Robyn, Management Quarterly

Both federal and state legislative and regulatory bodies have been moving decisively toward deregulation of major portions of the electric industry. Major legislation has been enacted in a handful of states, most notably California and Pennsylvania. Major electric industry restructuring proposals are also pending before legislative and regulatory bodies in Arizona, Idaho, Illinois, Michigan, New York, New Jersey, Vermont and numerous other states.

Although important aspects of these deregulation efforts remain unresolved (and will differ from state-to-state), major elements have taken shape. To date the primary input into this process from the electric utility industry has been from the vertically integrated investor-owned utilities, which are jurisdictional in nature and these rates are regulated by state public service commissions. However, electric utility restructuring legislation will also have profound implications for cooperative electric utilities, which differ substantially in structure and nature from investor-owned utilities.

The purpose of this article is to discuss some of the special issues that restructuring legislation may raise for cooperatives and to suggest possible approaches to these issues.

Background

The business of providing electric service historically has been viewed as a natural monopoly in the United States. A single utility generally has been authorized to provide electric service throughout a designated service area. The utility is obligated to provide reliable electric service to all members of the general public within the designated service area. This generally has included an obligation not only to install and maintain low-voltage electric distribution lines, but also to ensure a reliable source of energy supply, and to arrange for high voltage transmission of electric energy to the local distribution system. In return for accepting these obligations, the utility generally is granted the exclusive right to provide electric service within the designated area.

During the last two decades, a sizable industry of non-utility generators ("NUGs") has developed to compete with traditional utilities in the supply of electric energy. Particularly in light of technological advances in combustion turbine technology, together with dramatic reductions in the price of natural gas burned in such generating facilities, NUGs often have been able to produce electricity at costs substantially below the average cost of the local utilities. Beginning with the Public Utilities Regulatory Policy Act of 1978, and continuing with the Energy Policy Act of 1992, Congress has made it easier for NUGs to displace energy produced by traditional utilities in meeting the requirements for energy supply within their service areas. In many cases, NUGs have sought to "bypass" the local utility altogether by installing electric generating plants on the sites of major industrial or commercial users.

This "cherry picking" of utilities' largest electric customers now threatens the economic viability of all traditional utilities, investor-owned, cooperative and municipally-owned. The historic practice of prohibiting NUGs from competing in the supply of electric energy conflicts with long-standing federal policies encouraging competition. Many commentators and consumer advocates believe that this practice also has resulted in artificially high electric rates.

Traditional utilities have taken the position that they would be unable to recover the full amount of their prudently-incurred costs of generation-related assets and obligations in a fully competitive energy supply market. The position of the investor-owned utilities has been that opening the electric generation markets to full competition without providing for full, or at least partial, recovery of the investor-owned utilities' "stranded costs" would violate the "regulatory compact" pursuant to which the investor-owned utilities were induced to make investments in generation-related assets and to incur generation-related obligations. …

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